How Will Facebook Make Money?

For many of people, Facebook is the first stop in any Web surfing session. It has developed into a highly engaging combination of online bulletin board, personal scrapbook, and group communication network. But did you ever wonder why, being all those things, Facebook is free?

Well, it really isn't. Facebook offers its service in exchange for the right to capture and collect mountains of demographic and preference data from its users (you mean they didn't tell you that when you signed up?). That data can be extremely valuable to marketers and advertisers because it is highly detailed and personal.

Many Facebook observers believe that the company hopes eventually to license parts of its "social graph," or profile information database, to external marketers and advertisers who might use it to target ads or other content to potential customers. But to be useful to marketers, the user data must be set to "public," and Facebook has come under intense scrutiny over its handling of the privacy of its users' data of late. In light of the current backlash, any quick moves by Facebook to monetize its user data could prove disastrous.

What will Facebook do?

Low-Hanging Fruit: Facebook's Business Today

Today, Facebook is mainly an advertising platform. It sells ad space on its site, and it helps its advertisers aim their ads at specific groups of Facebook users, based on "public" elements of its members' profile data. Facebook also takes in a small amount of money through revenue-sharing agreements with developers who offer apps on Facebook: Facebook hands over a certain amount of "public" profile data to the app makers, enabling them to personalize the experience of the app's end users.

And that's it.

Some observers, such as Tom Phillips, CEO of social marketing company Media6Degrees, believe that Facebook's userbase is so massive, and its database of user data is so rich, that it can do good business simply by selling ad space and by hosting apps on its own platform. "With the amount of volume they have, they only have to do simple things," Phillips says. "They can make enough money selling big marketers volume impressions online, by running ads at their own site based not on keywords but on the actual tastes and preferences of Facebook users."

To be sure, Facebook has focused on increasing its membership, and it has been wildly successful on that score: the number of Facebook accounts is now nearing 500 million. So the sheer size of the Facebook audience is attractive to advertisers and app makers; and as a bonus, Facebook provides data tools to advertisers that help them make meaningful impressions on members of that audience.

But the company is deeply indebted to its venture capital backers, who, while already seeing dividends from Facebook's current business, are looking forward to a big payday (investment plus return) at some visible point in the future. For now, Facebook's investors are giving Zuckerberg and company plenty of time. People familiar with the situation say that you won't see a Facebook IPO this year or next year, but you probably will see one in 2012.

Still, Facebook has already taken some bold steps in that direction, periodically marching out new features to capture more user data for its massive "social graph"--and trying to make as much of that data "public" as possible. That public data is what marketers use to ensure that they are knocking on the right doors (websites) with the right marketing messages (ads, usually) to sell products. But those same bold moves have earned it the ire of many critics concerned about the privacy of user data.

So the interesting question isn't "How does Facebook make money right now?" but "How does Facebook intend to leverage its massive store of data to achieve full profit-making potential over the next two years?"

Stay the Course?

For the most part, Facebook has restricted its business partners to using the data it provides to approach users within Facebook. For example, Facebook gives onsite advertisers and app developers the advantage of its user data to help them target ads and customize the content in apps. Facebook does not directly charge those partners for the privilege, however. That could change.

According to Harvard Business School professor Ben Edelman, Facebook could stick with its current money-making model, but start charging for things that it does for free now. "Facebook may be using the old crack dealer model--the first puff is free," Edelman says. After app developers and partner Websites get 'hooked,' Facebook could start charging for access to its user data, he says.

Edelman believes that many of Facebook's current business partners would be happy to pay. "If American Airlines can afford to spend $100,000 to somebody to design their page, I imagine that they could afford to pay $10,000 a year to Facebook itself," Edelman says.

Sitting on a Gold Mine?

To marketers, the Facebook data is potentially more valuable than the data collected by other massively popular sites, like Google. That's because Facebook collects a rich set of personally identifiable information (PII) from its user profiles. The data contains not only the user's demographic data, but also data about their online and offline likes and dislikes--and those of their friends. The personal and social detail of Facebook's data could give marketers unprecedented power to find new customers.

A Facebook profile may contain your age, sex and location information. It might also know that you are an avid runner who attended a wine-tasting party last Tuesday night. It might even know for example, that you recently visited the Websites of MSNBC.com and MoveOn.org. A marketer such as Coca-Cola or Saturn or Nike, could compare this combination of demographic and preference data, and determine your similarity to people who have already bought their products.

But there's more. Facebook also collects and makes "public" the list of people who are your Facebook friends. If a marketer is looking to reach people who have a good chance of going out and buying their product, they might naturally want to focus on people whose friends have already purchased that product, explains Tom Phillips of Media6Degrees.

That sort of "social marketing" is a much more fine-grained and effective way of targeting potential customers than relying on the traditional demographics approach (for example, "42-year-old men in Montana often buy Ford trucks"). The tastes and buying habits of your circle of friends, in other words, are much better predictors of what you are likely to buy, than are your age, sex, and location data.

Phillips's company has made a business of finding (and scoring) similarities in the social data of different groups of people, yielding a "social graph" of preferences. Phillips says that one of his company's clients might provide Media6Degrees with a list of its customers, and then ask Media6Degrees to find people with similar social graphs from within its database of roughly 20 million people, the assumption being that similar people with similar tastes are likely to buy similar things--that they share a "common brand affinity."

But some Web marketers, including Media6Degrees, are steering clear of Facebook user data, fearing that using it could sweep them into the center of the current privacy firestorm alongside Facebook itself. Though Media6Degree's success depends entirely on the breadth and depth of its database of (social) people, Phillips says that his company has no interest in adding Facebook's data to its current collection. Why? Because Facebook's massive database is full of PII, and the stigma associated with such data is so great right now that Media6Degrees might face a privacy backlash of its own if it added some of that content to its database.

Anonymous Social Marketing?

Critics have long suspected Facebook of harboring plans to sell or license big chunks of its social graph to large Web marketers, but to date, the company has not done so. Will it? Most observers think so. "I don't think Facebook can get to where they want to be without doing that," Harvard's Edelman says. Facebook's central challenge is to figure out a way to make money from its user data without further inflaming consumers, advocacy groups, and government bodies such as Congress and the FTC.

Eric Wheeler, CEO of 33Across, another Web marketing firm, says that his company routinely licenses user data from blog sites, social media sites, and app developers, but doesn't collect the actual IP addresses, names, or e-mail addresses from those sites. "There is no PII; We don't need it, so none of that ever touches our system," Wheeler says. Instead, 33Across uses cookies. A company like Sprint (a 33Across client) might provide 33Across with a list of its current customers, and then ask 33Across to track the online social interactions that those customers have with others. If 33Across determines that a particular contact might be likely to buy a Sprint product, the firm drops a cookie into the contact's browser so that a relevant Sprint ad can be served up there in the future.

Wheeler believes that Facebook, using its wealth of user data, could take a similar approach. Or Facebook could decouple its user data from its platform and license it to companies like 33Across (Wheeler says that he'd love to have access to Facebook's data) or directly to large marketers like Nike, but in an anonymized form that contains no personally identifiable information.

Watching and Waiting

At the moment, Facebook is closely watching the privacy backlash and the debate that has been raging since the company's last privacy settings overhaul in late April. The public outcry has prompted talk in Washington, D.C., about the need for a social networking privacy bill, as well as a Federal Trade Commission investigation into the data management practices of Facebook and Google.

Though Facebook has a habit of bulling forward with new programs--and asking for forgiveness afterward rather than for permission in advance--the company is unlikely to try to license large chunks of PII from its database to marketers anytime soon. The air around Facebook and its data is so highly charged right now that Zuckerberg and company have good reason to move cautiously in the near term.

If Facebook users suddenly began receiving direct-marketing come-ons based on personal information harvested from their Facebook profiles, the result could be a user revolt, followed by class-action lawsuits, followed by government intervention.

So Facebook watches and waits to see where the chips fall in the current policy debate over online privacy. It also awaits the fate of Rick Boucher's bill in Congress, and the FTC's conclusions about Facebook's and Google's business practices regarding privacy.

Much of the online advertising industry hopes to be free to regulate itself, unfettered by a rigid set of rules imposed by the Congress or the FTC.

Facebook's earlier behavior has pushed the advertising and regulatory communities toward a showdown over privacy. After the dust settles and everyone--consumers, lawmakers, Web advertisers, and privacy groups--is heard, perhaps a set of rules will emerge by which Facebook can measure its moves and ambitions going forward. The company's future depends on finding just the right balance between the privacy expectations of its users and the quality of the social marketing data it can serve to its business partners.

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